On Monday, May 14, something happened that hasn’t happened since Dec of 2008. Two successive near-month precious metals futures contracts were in backwardation at the same time. To oversimplify, backwardation is when the price of a futures contract is lower than the price in the spot market. It should not be possible for it to happen in gold and silver (see my article).
But ever since Dec 2008, it has been recurring intermittently, and recently it has become the “new normal” for each futures contract to head into backwardation before expiring (see here).
Even in this “new normal”, however, it has been only one at a time: one metal, and one month. This is because the backwardation occurs with the “contract roll”, as people sell the expiring contract and buy one farther out. The selling pressure on the expiring contract is most intense for a short period of time. After that, the spread widens as the market makers move on, the selling pressure abates, and with wider spreads all around, both the basis and cobasis fall into oblivion. Except for the December month, gold and silver futures are liquid in different months.
That is why one does not see both monetary metals in backwardation simultaneously because they are “out of phase” by 30 days and temporary backwardation typically persists for only about a week or so. And it should be even harder to see two different successive near-dated futures contracts in backwardation.
On May 14, this is precisely what occurred. Both May and July silver are backwardated. And June gold is backwardated. Incredibly, the May silver contract is giving away a 3% annualized profit to anyone who would sell physical silver and buy a May future that delivers in a few weeks (thus recovering the same position). Even more incredibly, no one can or will take the profit that is dangling out there!
July silver backwardation is smaller, and June gold backwardation is even smaller. But still! This should not be possible at all.
Because the next successive contracts are not in backwardation (in silver, all contracts from Jul 2015 on are backwardated), it is not a collapse of trust. I think that it is a lack of unencumbered metal. The markets for precious metals, silver more than gold, have become quite tight.
Keith Weiner is the founder DiamondWare, a VoIP software company, and is a PhD student at Antal Fekete’s New Austrian School of Economics in Munich. He is now a trader and market analyst in precious metals and commodities. He is also president of the Gold Standard Institute USA.
© 2012 by Keith Weiner
How can the common investor/trader profit from this event?
John, I am reluctant to offer trading advice in this forum where it may not be appropriate, but what I am saying is that there is a scarcity in the market for these goods and at the same time we can see that the price has fallen. :)
But Keith, surely scarcity in the market for silver & gold can only imply a lack of trust? You can’t have it both ways, since neither silver nor gold is scarce.
HSBC’s SLV silver might be encumbered but why won’t those encumbering it hit the spot bid?
JR, all silver futures from Sep 2012 through May 2015 are not in backwardation. Several are even in contango, i.e. Future(bid) > Spot(offer).
I have thought about this a great deal. I am open to other arguments, but I think if trust were collapsing then it would look all different. For one thing, the farthest futures would fall into backwardation first and biggest, and the rot would creep back to the present month which might or might not be in backwardation.
In other words, why worry about May delivery in two weeks? And if there truly is a reason to worry about financial collapse in the next two weeks, there would be no bloody bid AT ALL for May 2015, would there??
Also, gold is a perfect contango market right now, except for June. If collapse were imminent, I rather think gold would be in backwardation also.
And then there is the price. Right before collapse, the price will be skyrocketing, I believe.
Just my own opinion Keith but I see the idea of ‘perfect contango’ in gold as irrational, when considering US debt, which is junk, as is just about all other debt on the balance sheets of banks worldwide. There is no quality there, unlike gold.
It’s a credit bubble, so not conducive to analysis. Quantifying a qualitative argument is difficult to say the least. It could be that these bases & cobases of COMEX futures are not telling you what they think they are.
what you think they are.
Here’s a Bloomberg article I found the other day – http://www.bloomberg.com/news/2012-05-14/treasury-demand-shows-deficits-irrelevant-with-record-yields-1-.html
It’s different this time?
A permanently high plateau?
The shoe shine boys are giving stock tips?
Gold is a perfect contango?
JR: The dollar world is a closed loop. All dollars go back to the Treasury bond market. The Fed is buying Treasurys and this fuels hordes of speculators to front-run them. The rate of interest has been falling for 31 years.
This is *NOT* a statement of the quality of the Treasury bond! This is a statement about the design of our obscene monetary system.
My adjective “perfect” contango refers merely to the mechanical aspect that the basis is monotonically rising and the cobasis is monotonically falling from Aug 2012 through 2016. If you’ve read my other writings, you know I don’t believe it will last.
Both May and July silver are backwardated. And June gold is backwardated. Incredibly, the May silver contract is giving away a 3% annualized profit to anyone who would sell physical silver and buy a May future that delivers in a few weeks (thus recovering the same position). Even more incredibly, no one can or will take the profit that is dangling out there!
Keith, can you clarify the actual percentage gain, not the annualized gain? 3% is OK given today’s level of interest rates, but if one is dealing with very small time intervals, then the absolute gain might be negligible. Plus, there are bid-asked spreads/commissions to consider, as you very well know.
Doc: For May, the contract settles on or before May 29. Two weeks would be 1/26 of a year, so 3/26 = 0.115% on an absolute basis.
The bid-ask spread is precisely what this analysis considers. To decarry silver, one must sell physical silver on the bid and buy a future at the ask. Cobasis = Spot(bid) – Future(ask).
I agree, this is not an opportunity for a small retail trader who must pay commissions. It is an opportunity for an institution, who does not have the fees and commissions to pay. For example, HSBC as I recall is the custodian for SLV. They have tons and tons of physical silver sitting there, and yet they do not take this spread. Why not? I think the metal is already encumbered in some way.
Could it be silver miners arete hoarding?
http://www.wyattresearch.com/article/why-silver-miners-are-hoarding-silver/26668
And does “encumbered” mean the silver is commuted to something else, for example, if it were leased out to the max?
[...] This might be a bit advanced if you’re new to precious metals but it is a very important concept to understand. At the very least it could raise some questions and get you to do a bit of digging. In an article a week ago Keith Weiner wrote how gold and silver are in backwardation. [...]